Invest in Real Estate with a Self-Directed IRA

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Contributor, Benzinga
Updated: July 18, 2022

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Did you know that it’s possible to invest in more than just stocks, bonds and mutual funds through your individual retirement account (IRA)? With a self-directed IRA, you can diversify your investments with precious metals and real estate purchases. In some cases, using your existing IRA funds to invest in property can create a profitable stream of retirement income with a few unique tax benefits.

Investing through a self-directed IRA can be a complicated process. Our guide will help you determine if this investment is right for you and how you can get started. 

How to Invest in Real Estate with an IRA

You cannot invest in a property with any type of IRA. Our guide will help you understand the process of setting up a self-directed IRA and investing in property using your IRA funds.  

1. Convert your IRA to a self-directed IRA.

You should already understand the IRA investing process before you convert your account to a self-directed IRA. If you don’t already have a traditional or Roth IRA, set it up and start making contributions before you consider investing in a self-directed IRA.

If you already have an established IRA, you’ll need to choose a custodian to service your self-directed IRA. A custodian is a financial institution that handles tax reporting and other required documentation for your IRA account. Each year, you must report your IRA’s holding to your custodian for tax purposes. After you choose a custodian that supports property investments in self-directed IRAs, open your IRA account and roll over your existing funds to your new account.   

2. Choose a property and purchase it using your IRA funds.

While you’re setting up your self-directed account, you can begin comparing properties for sale. You might want to hire a real estate agent or realtor to make your process simpler and more streamlined. Take a look at the current amount of money you have in your existing IRA and use it as a guide to determine how much “house” you can afford. Remember that home expenses (like title searches or improvements) must also come out of your IRA funds.

The easiest way to purchase property with your IRA is to pay for it in cash. However, you can use a partnership or undivided interest to purchase the property in some cases. You cannot use a traditional mortgage loan to fund the purchase.

Remember that you also cannot live in the home or gain any immediate personal benefits from the property you choose. When you compare properties, consider location, investment and potential rental income before you choose where to invest. When you find a property, submit an offer letter to the seller in the name of your IRA. If the seller accepts the offer, proceed with the transaction and put the name of your IRA on the title of the property. Your custodian will assist you in closing escrow on your property and titling it correctly. 

3. Decide how you want to use the property.

After the sale of the property closes, you’ll need to decide how you want to use the property. Remember that there are a limited number of ways you can use the property according to IRA rules. We’ll go over them in a later section.

Most investors who purchase a property using their self-directed IRA “flip” the home and put it back up for sale or rent the property out to tenants. If you decide to rent the property, any rental income must be returned to your IRA account. If you sell the property, the proceeds must go to your IRA. 

Must Know 

Investing in a property with your IRA comes with a number of rules and regulations. If you fail to adhere to these rules, your purchase could be disqualified from your IRA. This would make all of the money spent taxable. Be sure to take note of these rules before you decide that you want to add a property to your IRA. 

  • You cannot gain any personal benefits from the property. The most important rule for investing in property through your IRA is that you cannot gain immediate personal benefits from the residence. You cannot live in the home that you invest in as a primary or secondary residence or use it as a vacation home — that includes members of your family (if paying rent or not). If the property is a commercial space, you cannot operate a business from the property or rent any type of office space in it. The residence must purely be an investment to generate income through rent, appreciation or both. 
  • You cannot purchase a property from a “disqualified party.” In addition to how you use the property, IRA rules also dictate which properties you can purchase. You cannot purchase a property that you already own or a property that is owned by your spouse, your children, your parents and other family members. This is referred to as “self-dealing” and immediately disqualifies your investment from your IRA.  
  • The property must be owned by your IRA. Properties purchased using a self-directed IRA aren’t titled in your name. Instead, the property is purchased using the name of your IRA, which is also found on the title.  
  • You cannot manage the property yourself. In addition to living in the home, managing the property yourself is also forbidden. You must pay for an independent 3rd party to manage the property if you have tenants and to perform any necessary repairs.   
  • You must pay for property expenses out of your IRA. In addition to hiring an independent party to manage and repair the property, you must also pay for any and all property-related expenses using the funds in your IRA. This includes repair bills, property taxes and anything else you spend maintaining the property as an income-generating investment. If you don’t already have enough funds in your IRA to cover these expenses, this can create problems and potentially disqualify your investment. 
  • You cannot use a mortgage loan to purchase the property. Most homeowners use a mortgage loan to purchase their primary residence with a small down payment, usually between 3% and 20% of the value of the home. According to IRA rules, you cannot use a mortgage loan to purchase the property in your portfolio.

This doesn’t necessarily mean that you need to purchase the property in cash — though this is how many account holders add properties to their IRAs. You can also use undivided interest in your IRA account and partner with another investor to purchase the property. In some rare instances, you can finance a property investment by using a non-recourse loan issued to your IRA, you’ll need to structure the loan properly and pay unrelated business income taxes on the amount that you borrow.  

Invest With A Real Estate Investment Platform

Purchasing a property directly isn’t the only way to add real estate investments to your IRA. There are a number of real estate investing platforms that allow you to invest in residential and commercial projects online through crowdfunding without the hassle of ensuring that you’re following all of the rules listed above when purchasing the property directly.

Fundrise, one of the most well-known and trusted real estate investment platforms, actually has its own IRA product. With a minimum investment of just $1,000, you can add a diverse portfolio of institutional-quality real estate assets to your retirement account. Learn more about the Fundrise IRA.

Browse a few of our other favorite real estate investing platforms below. 

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Pros and Cons of Self-Directed IRAs

Self-directed IRAs can be beneficial for some investors and a nightmare for others. Let’s take a look at the pros and cons of investing through a self-directed IRA. 

Pros

  • Tax benefits: Although a self-directed IRA operates differently than a standard IRA, it still offers many of the same tax benefits. Say you open a self-directed Roth IRA and invest in a property, any income deposited back into the account through rent or an appreciation after a sale will be tax-free when you withdraw it after retirement.
  • More control over your investments: If you’re a hands-on investor, you’ll appreciate the level of control your self-directed IRA gives you over your investments. For example, if you invest in a property through your self-directed IRA, you get to decide if and when you sell it, rent it out or make improvements to it.
  • Higher return potential: If you understand the stock market well and you have experience managing properties, a well-executed property purchase using your IRA can create a consistent stream of tax-free income. While a higher return potential isn’t guaranteed, self-directed IRAs have more potential for passive income generation. 

Cons

  • More complicated fees and paperwork: To stay within IRS rules, you’ll need to hire a custodian to assist you in the self-directed IRA setup and investment processes. This custodian will charge you an additional fee in exchange for services.
  • More rules related to your investments: If you buy property through a self-directed IRA, you’ll need to adhere to the myriad of rules related to management and use of the property. Violating these rules can make your entire investment taxable.
  • Expensive investments require capital: Investing in real estate is an expensive endeavor. You must already have an established IRA before you can consider investing in property through a self-directed IRA. If you don’t have enough money to cover maintenance, repair and renovation expenses in your existing IRA, this probably isn’t the best option for you. 

Transitioning to a Self-Directed IRA

Before you can consider purchasing property through a self-directed IRA, you’ll need to open and fund a standard IRA. Thankfully, getting started with a traditional or Roth IRA is easier than ever. If you aren’t sure where to begin, consider a few of our favorite IRA providers.  

Accelerate Your Wealth

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